Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 404

A year like few others, but what's next?

The one-year anniversary of the low point in the S&P 500 index during the pandemic was 23 March 2021, so we want to put the trailing one-year return of 77% into context as we look ahead.

This was a rare event

With the help of Bernstein Research, we calculated trailing 12-month returns for every month-end beginning in 1882. We then aggregated all the return streams into buckets, as shown below. So, how rare was this past year’s return? Extremely.

Exhibit 1: Only a handful like it

All five previous examples of 75% or greater 12-month trailing returns occurred during the Great Depression of the 1930s, another period of extraordinary government economic intervention.

What’s unique about the response to the coronavirus pandemic is the speed at which the US economy exited the recession once the US Federal Reserve put a floor under credit risk.

Markets may be short term, but they’re not dumb

Financial markets are a discounting machine. They tend to ignore seemingly material factors such as high unemployment while zeroing in on things that really matter, such as free cash flow generation.

For instance, in the quarters preceding Franklin D. Roosevelt’s New Deal, investors looked through intense economic pain and suffering in anticipation of an explosion of economic growth in 1934. What followed was a strong, but short-lived, business cycle. After the effects of the early-New Deal stimulus had worn off in 1937, worries about deficits resulted in spending cuts and the economy contracted again. Financial markets anticipated that too, as evidenced by the rollercoaster market returns throughout the 1930s.

Bringing it back to the present day, following the lows of last March, the beneficiaries of the initial phase of the rally were stay-at-home stocks such as streaming services and video conferencing providers.

However, as the weeks passed, investors began to look though the uncertainty surrounding the virus to what could be a massive snap-back in US economic growth in the second half of 2021. They switched their focus, shifting capital away from free-cash-flow compounders — companies that are typically more in control of their own destinies — and toward the stocks and credits most leveraged to the economic outlook: cyclicals.

The significant outperformance of companies with highly indebted balance sheets or lower-quality income statements is characteristic of the early phase of a market cycle. Regardless of quality, those companies that are most directly leveraged to a rebound in economic growth have historically become market darlings. That pattern played out during the previous two business cycles, after the collapse of the dot-com bubble and again in the wake of the global financial crisis.

I don’t discount what the market is signaling. It may be short term, but it’s not dumb. The combination of an exceedingly high US savings rate (thanks to pandemic-driven government transfer payments) and pent-up consumer demand (after more than a year of lockdowns) should lead to an enormous pop in economic growth.

Exhibit 2: US stimulus has ballooned savings

Cross-cycle compounders will replace cyclicals

Most investors focus on the near term. That will probably never change. Therefore, it comes as no surprise that the market’s ability to predict what will happen in the short term is strong but weakens over the medium and long term. That’s why our focus is always on the out years.

At some point, as they always do, financial markets will look through the coming eye-popping economic statistics. They will begin to discount what business fundamentals will look like without the tailwind of exceptionally accommodative fiscal and monetary policy.

And if history is any guide, we expect that as policy normalises, investors will pivot back to the type of cross-cycle earnings-compounders that make up many of our core holdings. These 'compounders' grow or 'compound' their earnings better than lesser companies across cycles as their revenues hold up in difficult conditions. They deliver strong cross-cycle earnings growth.

Cyclicals will have had their day, as they often do in the early phases of a market cycle, but we believe secular trends will win out in the long run, rewarding patient investors as the cycle matures.

 

(Editor's note: A stock is secular when company earnings remain relatively constant regardless of other trends. Examples are consumer staples or products that households consistently use. A cyclical stock's price is more affected by changes in the economy).

 

Robert M. Almeida is a Global Investment Strategist and Portfolio Manager at MFS Investment Management. This article is for general informational purposes only and should not be considered investment advice or a recommendation to invest in any security or to adopt any investment strategy. Comments, opinions and analysis are rendered as of the date given and may change without notice due to market conditions and other factors. This article is issued in Australia by MFS International Australia Pty Ltd (ABN 68 607 579 537, AFSL 485343), a sponsor of Firstlinks.

For more articles and papers from MFS, please click here.

Unless otherwise indicated, logos and product and service names are trademarks of MFS® and its affiliates and may be registered in certain countries.

 

RELATED ARTICLES

The options to gain equity exposure with less risk

Is your fund manager skilful or just lucky?

Four tips to catch the next 10-bagger in early-stage growth

banner

Most viewed in recent weeks

10 little-known pension traps prove the value of advice

Most people entering retirement do not see a financial adviser, mainly due to cost. It's a major problem because there are small mistakes a retiree can make which are expensive and avoidable if a few tips were known.

Check eligibility for the Commonwealth Seniors Health Card

Eligibility for the Commonwealth Seniors Health Card has no asset test and a relatively high income test. It's worth checking eligibility and the benefits of qualifying to save on the cost of medications.

Hamish Douglass on why the movie hasn’t ended yet

The focus is on Magellan for its investment performance and departure of the CEO, but Douglass says the pandemic, inflation, rising rates and Middle East tensions have not played out. Vindication is always long term.

Start the year right with the 2022 Retiree Checklist

This is our annual checklist of what retirees need to be aware of in 2022. It is a long list of 25 items and not everything will apply to your situation. Run your eye over the benefits and entitlements.

At 98-years-old, Charlie Munger still delivers the one-liners

The Warren Buffett/Charlie Munger partnership is the stuff of legends, but even Charlie admits it is coming to an end ("I'm nearly dead"). He is one of the few people in investing prepared to say what he thinks.

Should I pay off the mortgage or top up my superannuation?

Depending on personal circumstances, it may be time to rethink the bias to paying down housing debt over wealth accumulation in super. Do the sums and ask these four questions to plan for your future.

Latest Updates

Investment strategies

Gullible travels, or are Aussies more sceptical?

Businesses exploit the psychological processes that people go through when they decide to buy something, but does the US research work when faced with "traditional hard-bitten, no-bullshit Australian scepticism"?

Retirement

Start the year right with the 2022 Retiree Checklist

This is our annual checklist of what retirees need to be aware of in 2022. It is a long list of 25 items and not everything will apply to your situation. Run your eye over the benefits and entitlements.

Retirement

Global survey shows Australians least confident about retiring

Australians are generally optimistic about retiring comfortably but their confidence lags retirement savers in other countries. They are also the most unsure about future returns and withdrawal rates in retirement.

Financial planning

Should I pay off the mortgage or top up my superannuation?

Depending on personal circumstances, it may be time to rethink the bias to paying down housing debt over wealth accumulation in super. Do the sums and ask these four questions to plan for your future.

Investment strategies

Morningstar asset class performance, 2021 and historical

As we enter a new year, we dive into the Morningstar database to see which asset classes have performed well over various time periods, with the related risks and largest historical drawdowns.

Investment strategies

At 98-years-old, Charlie Munger still delivers the one-liners

The Warren Buffett/Charlie Munger partnership is the stuff of legends, but even Charlie admits it is coming to an end ("I'm nearly dead"). He is one of the few people in investing prepared to say what he thinks.

Using past performance is a risky way to invest

We often assign quality in investment choice by historical returns, backed up when we see fund flows directed towards such historically well-performing funds. This is a mistake made by investors and regulators.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.